EU PRIIPs Regulation: Do you need a “KID” for your AIF?

The European Parliament and the Council of the European Union have introduced a set of regulations that aim to establish uniform rules on the transparency of packaged retail and insurance based investment products (PRIIPs) offered to retail investors in the EEA. These rules will be relevant to the distribution of alternative investment funds (AIFs) made available to retail investors in the EEA from 01 January 2018.

Although this note does not cover UCITS, you should note that there is a transitional period applying for UCITS which means that a KID (in the PRIIPs sense) does not have to be published when a UCITS is “made available” until 01 January 2020. A UCITS has its own key investor information document (KIID) which will remain in use until at least that date.

This note sets out some information relating to the implications of this regulation in the context of AIFs.

Is the PRIIPs regime relevant to AIFs and when does it come into effect?

The PRIIPs regime will apply to all products manufactured by the financial services sector which provide an investment opportunity to EEA retail investors where (irrespective of the investment's legal form) the product’s return is subject to the performance of assets which are not directly purchased by the EEA retail investor. AIFs will therefore constitute PRIIPs for the purposes of the regime.

The PRIIPs regime comes into effect on 01 January 2018.

What is the key requirement of the PRIIPs regime?

Before an AIF is “made available” to EEA retail investors, a key information document (KID) for the AIF must be drawn up by the manufacturer of the product (eg the AIFM) and published on its website. The KID will be required to be provided to a EEA retail investor in good time prior to their investment in the AIF.

In our view, an AIF may be considered to have been “made available” to an investor even if the original approach was unsolicited and therefore no “marketing” took place for the purposes of the Alternative Investment Fund Managers Directive.

What is a KID?

A KID is a short document providing key information to investors in relation to the relevant product eg an AIF.

KIDs will need to comply with strict requirements as to form and content set out in the PRIIP regulatory technical standards. These include requirements to incorporate performance scenarios and a risk/reward indicator which will require detailed formulae to be analysed and complied with.

To whom does the requirement to produce a KID apply?

The PRIIPs regime applies to both EU and non-EU AIFMs (as the PRIIPs manufacturers) and persons advising on or selling PRIIPs, including AIFs, to EEA retail investors.

Can others be indirectly impacted?

Yes. For example, if you are the AIFM of an AIF which is wrapped in another PRIIP (eg a fund of funds) and such other PRIIP is made available to retail EEA investors, you may be required to provide very specific data to enable the manufacturer of that second product to prepare a KID.

Who is a “retail investor” for these purposes?

A “retail investor” for these purposes will be a “retail client” as defined for the purposes of MiFID2. The detailed definition is set out in Article 4(1) of MiFID2 (Directive 2014/65/EU). This might include individuals (eg members of staff of the AIFM and high net worth individuals), smaller undertakings, municipalities and local authorities who do not or cannot “opt up” to “professional client” status (as regards to the “opt up” procedure, please see below).

What steps can you take to ensure the requirement does not apply?

The regime will not have any direct application where an AIF is not made available to retail investors in the EEA from 01 January 2018. Certain steps might be taken to achieve this:

Restrict access to the AIF by EEA retail investors

Such restriction might be reflected in the fund prospectus and subscription documentation in one of the following ways:

• Restrict investment from any EEA investor to those classified as “professional clients” under MiFID2 and those that meet the criteria and are willing to opt up to professional client status in accordance with the procedure set out in MiFID2. This could include the insertion of positive tick-box elections for clients within the application form.
• Add an acknowledgement that the AIF is for professional clients only but do not explicitly exclude EEA retail clients. (This carries a risk in the event an EEA retail client invests and sufficient diligence has not been carried out on the investor.)
• State that although the AIF is a product which falls within the scope of the PRIIP Regulations, no PRIIP KID will be provided as the AIF is not open to EEA retail investors for the purposes of PRIIPs. (This perhaps carries a higher risk if insufficient diligence is done on the investor.)

Exclude EEA retail investors from distribution activities

In addition to restricting access to EEA retail investors, the AIFM might ensure all distribution activities by it and third parties exclude EEA retail investors.

In the event there are third party distribution agreements, these should be supplemented with clear obligations to ensure that all investors, at the point of investment, are classified as professional clients for the purposes of MiFID2. An exception could be made for retail investors who are capable of being “opted up”.

Can existing EEA retail investors invested in the AIF be disregarded for these purposes and be allowed to retain their investment?

Yes, in our view.

There has been much debate around the meaning of “made available” in the context of the PRIIPs regime. Where EEA retail investors cannot make further investments in the AIF as of 01 January 2018, and any pricing being provided by the AIF is for the purpose of redemption only, we consider that the AIF is not being “made available” to EEA retail investors.

Can EEA retail investors be “opted up” to professional client status for these purposes?

Yes. EU investment firms may arrange for “retail investors” that satisfy certain criteria to opt-up to “professional client” status and therefore be disregarded for the purposes of the application of the PRIIPs regime.

It is the investor’s responsibility to keep the EU investment firm informed of any change that could affect their categorisation but the EU investment firm also has a responsibility to take appropriate action should the EU investment firm become aware that the investor no longer fulfils the relevant criteria.

The status of existing clients that EU investment firms have already categorised as professional clients/who have already opted-up to professional client status, such as family offices, pension schemes or wealth managers, will be unchanged (unless in the case of elective professional clients, that client informs the EU investment firm or the EU investment firm becomes aware that that client, no longer fulfils the necessary criteria). It is likely that the most problematic category of investors will be high net worth individuals, members of staff of the EU firm and friends and family.

Next steps?

AIFMs and distributors of AIFs should now undertake an exercise to determine the following:

• whether any relevant AIF will be made available to any EEA retail investors
• the steps to be taken to restrict access by and stop distribution to EEA retail investors and to opt-up all relevant investors currently classified as retail, to professional clients, where possible, and
• whether there is any potential indirect impact through having products wrapped in other products which are made available to EEA retail investors which will lead to data requirements.